Neighborhood Effects in Mortgage Default Risk Prepared for: U.S. Department of Housing and Urban Development Office of Policy Development and Research Prepared by: Robert F. Cotterman Unicon Research Coporation Santa Moncia, CA Under Contract: C-OPC-18484 March 2001 ACKNOWLEDGMENTS The author wishes to thank the staff of HUD Policy Development and Research, who have provided invaluable advice and assistance throughout the course of this project. Special thanks are due to Harold Bunce, Bill Reeder, and Sue Neal for extensive comments on an earlier draft and to Randy Scheessele for help in obtaining and understanding the FHA data. The contents of this report are the view of the contractor and do not necessarily reflect the views or policies of the U.S. Department of Housing and Urban Development or the U.S. Government. Preface This study examines the effect of neighborhood characteristics on the default of FHA mortgages. The analysis includes both neighborhood characteristics and characteristics of the individual loan and borrower, so that the effects of the neighborhood can be distinguished from those of the individual loan. In particular, the analysis seeks to distinguish the effects of neighborhood race, ethnicity, and income from the effects of the of the individual borrower's status. Research on the effects of neighborhood characteristics on default has been somewhat limited in the past, and this study's contribution to the literature is the inclusion of credit history data. The analysis finds that lower tract income and higher tract black composition are associated with higher rates of default, whereas individual borrower race or income are unrelated to default. The study then goes on to examine possible causes for these findings, including whether higher defaults reflect more limited access to mortgage finance (as measured by refinance probability) or a response to previous defaults in the neighborhood. The findings regarding access to refinancing are not definitive. FHA refinancing probabilities seem to be higher in minority tracts and are a least equal to low-income tracts. Refinancing through other non-FHA sources of refinance funds, including conventional, is statistically less in predominantly Hispanic and lower-income tracts for holders of FHA mortgages. The effects of neighborhood race and income on default are reduced when lagged defaults and prepayments and neighborhood house price change are included in the analysis. Although the higher default rate in lower-income tracts remains significant, the higher default rate in minority tracts becomes insignificant, suggesting that lower house price appreciation is an important factor in the higher default rates observed in minority neighborhoods.
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